The Central Bank of Nigeria: Battling Inflation with a Knife | by Oluwatosin Olaseinde

“The question remains, why is the MPC attempting to address inflation by increasing the lending rate, thereby reducing the money supply when the cause of Nigeria’s inflation is not, in fact, an increase in the money supply but an increase in price levels?”

Bearing in mind that the Nigerian economy is currently in a technical recession, one might expect the MPC to lean towards policies that will boost the economy and encourage loans to the real economy by keeping interest rates low.

With some of its members including the Governor of the Central Bank, the four Bank Deputy Governors, and two members of the Bank’s Board of Directors, the decisions made by the Monetary Policy Committee cannot be taken lightly. The committee has responsibility within the Central Bank of Nigeria (CBN) for formulating monetary and credit policy. The MPC maintains Nigeria’s external reserves to safeguard the international value of the legal currency; with the ultimate intention of promoting price stability and a sound and efficient financial system. The MPC is, further, intended to act as banker and financial adviser to the country’s federal government; and be a lender of last resort to banks.

As of June this year, an inflation rate of 16.5% means that an investor must earn a minimum 16.5% return on his or her investment to achieve any real growth. Anything below 16.5% means that inflation will have eroded any positive growth.

Bearing in mind that the Nigerian economy is currently in a technical recession, one might expect the MPC to lean towards policies that will boost the economy and encourage loans to the real economy by keeping interest rates low. However, it actually isn’t that simple because the question of rates in Nigeria is a more structural one.

The CBN is currently faced with a dilemma. On the one hand, there is the argument that monetary policy should be eased to boost flagging economic growth. This would involve reduced interest rates so that the real economy can borrow for less. Borrowing that will then be invested in the economy through increased spending. On the other hand, however, inflation is currently on a high – going from 12.8% in March, (at the time, a four-year high), to a now eleven year high of 16.5% as of June.

From single digits of 9.6% in January to high double digits in June, in the space of 6 months, inflation has grown by over 7%.

Tied to a sharp jump in power and energy prices, and a much weaker exchange rate, which in turn, reduces the value the consumer gets from the naira, high inflation seems the most likely target of the MPC’s recent decision to increase the lending rate. By increasing interest rates and, thereby, reducing the flow of money into the system as many will find it too expensive to take on debt by borrowing, the overarching result might be to stem the rise in inflation.

Although this works out in theory, in practice – and due to the peculiarity of the Nigerian market – the situation is a slightly different one. Nigeria saw inflation surge for the 5th consecutive time this year. From single digits of 9.6% in January to high double digits in June, in the space of 6 months, inflation has grown by over 7%. Inflation can be either the result of an increase in the money supply or an increase in price levels. The inflation that Nigeria is currently experiencing is not driven by a higher money supply but rather by higher price levels. So when we hear about inflation in Nigeria, we are hearing about a rise in prices compared to some established benchmark.

Figure 1 Source: Trading Economics

Recently, the CBN introduced a flexible foreign exchange regime (the “float”) and this saw N1.2 trillion leave the system as the CBN addressed a backlog of dollar demand. In other words, the CBN bought naira in exchange for supplying dollars to those demanding foreign currency. This means that there is less supply in money. On the other hand, a 45% rise in electricity prices and a 70% jump in the petrol price, coupled with a weak exchange rate has led to significantly higher price levels. The question remains, why is the MPC attempting to address inflation by increasing the lending rate, thereby reducing the money supply when the cause of Nigeria’s inflation is not, in fact, an increase in the money supply but an increase in price levels?

This is perhaps a question only the MPC is in a position to answer, but it is worth remembering that the MPC emphasised its commitment to act as a complimentary force to fiscal policy in its aim to boosting economic activity. For growth to be real, the impact of inflation must be eliminated. As of June this year, an inflation rate of 16.5% means that an investor must earn a minimum 16.5% return on his or her investment to achieve any real growth. Anything below 16.5% means that inflation will have eroded any positive growth.

The monetary policy committee has over the past year made decisions to adjust interest rates in both directions from 13% to 11% to 12% to 14%.

And still, it is struggling to meet its desired impact. There is clearly a need for monetary policy to be more effectively combined with the country’s fiscal policy in order to achieve sustained economic growth. Without this, it would appear that the MPC is going into a gun fight with a knife.

Oluwatosin Olaseinde is a Nigerian. She is a chartered accountant with 7 years’ experience across audit and corporate finance and research.